States on Track for Default

NEW ORLEANS, La. – On account of immense fiscal pressure, some states are “simply not going to be able to honor their promises,” asserts John Hood, author of “The States in Crisis,” a report from the latest issue of National Affairs.

Hood is president of the John Locke Foundation, a North Carolina policy institute, and he cites an estimated $3 trillion in state and local unfunded liabilities and a combined projected deficit of $130 billion for the coming year. That equates to around 20 percent of their total spending, and nearer to 30 percent in the case of Louisiana. Hood also doubts whether federal officials, who have channeled $140 billion of relief to states over the past three fiscal years, will continue aid of that magnitude. (Article continues below.)

Reproduced with permission from National Affairs. Data Source: Center on Budget and Policy Priorities.

The latest recession brought lower state tax revenues – 8.4 percent less in 2009 than in 2008, and a further 3.1 percent less in 2010. However, the problem will not go away, he says, even in the event of an economic recovery. States have roughly doubled their spending over the past fifty years, as a proportion of the economy, and the “fiscal calamity is not simply a function of the recession.”

“Their shaky financial foundations were in fact set long ago – through unsustainable obligations like retirement benefits for public employees, excessive borrowing, and deferred maintenance for public buildings and infrastructure.” (Click below for an in-depth interview with John Hood – 28 minutes.)

[audio:http://bit.ly/ieSIcR]

The report draws heavily on data from the Pew Center on the States – a division of the independent, non-profit Pew Charitable Trusts – which includes state comparisons and profiles. Louisiana draws the worst categorization available with “serious concerns,” on account of 30 percent unfunded pensions and completely unfunded retiree health and other non-pension benefits. As of 2008, Louisiana had the 10th highest per capita unfunded liabilities of all the states, at $24 billion and nearly $6,000 for every resident.

Since states in the worst positions already have the heaviest tax burdens, such as California and New Jersey, Hood does not see higher taxes as a plausible solution. Higher marginal tax rates will push wealthier individuals, he says, to simply transfer and shield their assets in lower-tax states.

“As a practical matter, most of the solution is from the spending side… In some cases, states are simply not going to be able to honor the promises that they issued.”

Beyond rescinded promises, current and future taxpayers shall shoulder the fiscal reckoning that has accumulated over the decades. Hood describes this imposition as unjust, but still “the bills have to be paid… You can’t just tell bond-holders you get nothing.”

His concern now is that cuts are made in a “sober and deliberative manner, rather than having to slash and burn over three or four months… I fear, even as states properly reduce their budgets, they’re going to resort to across the board [cuts].”

Hood gives more emphasis to long-term solutions, but for the short-term he suggests, among many ideas, consolidating redundant departments and agencies, selling off low-priority assets, and placing more government services into competitive contracting.

His long-term priority is a conversion of all state retirement plans from defined benefit to defined contribution. A defined contribution plan sets aside an agreed portion of wages, and then benefits accrue from that portion. A defined benefit plan, on the other hand, works backwards and is vulnerable to abuse. State officials promise retirement benefits and then set aside what they believe is necessary, or even nothing at all. Typically they do not set aside enough, since in 2008 not one state had set aside assets sufficient to cover future obligations.

Then he identifies the tendency of states to borrow recklessly, likening them to a teenager without the long-term incentives, knowledge, or self-discipline to make wise decisions. He would strengthen constitutional impediments to borrowing, confining it to non-operating expenses, and he would give governors item-reduction veto power. He also advocates the removal of federal tax exclusions that favor lending to state governments over private borrowers.

He calls for state leaders to reject federal aid, which recent research suggests only exacerbates states’ long-term fiscal difficulties. And he describes debt-enabled federal aid as “egregious.”

“States have balanced budget requirements, and they can’t pay their bills. Instead of cutting spending they get the federal government to borrow on their behalf, which is arguably a violation of their own constitutions.”